1. Chapter 27
Further consolidation issues I: Accounting for inter-entity transactions and minority interests
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2. Objectives
Understand how and why to eliminate inter-entity dividends on consolidation
Understand how to account for inter-entity sales of inventory
Understand how to account for inter-entity sales of non-current assets
Understand what minority interests represent and how minority equity interests should be disclosed within consolidated financial statements
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3. Introduction to accounting for consolidation issues
Overview
During a financial period it is common for separate legal entities within an economic entity to transact with each other
In preparing consolidated accounts, the effects of all transactions between entities within the economic entity are eliminated in full, even where the parent entity holds only a fraction of the issued equity
(continues)
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4. Introduction to accounting for consolidation issues (cont.)
Examples of inter-entity transactions
Payment of dividends to group members
Payment of management fees to a group member
Inter-entity sales of inventory
Inter-entity sales of non-current assets
Inter-entity loans
Consolidation adjustments for inter-entity transactions
Typically eliminate these transactions by reversing the original accounting entries made to recognise the transactions in the separate legal entities
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5. Dividend payments pre- and post-acquisition
In consolidation process it is necessary to eliminate:
all dividends paid/payable to other entities within the group
all dividends received/receivable from other entities within the group
Only dividends paid externally should be shown in consolidated financial statements
AASB 127 (par. 24)
On consolidation intragroup balances, transactions, income and expenses are all be eliminated in full
(continues)
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6. Dividend payments pre- and post-acquisition (cont.)
Dividends paid from post-acquisition profits
Only dividends paid externally should be shown in the consolidated financial statements
Journal entry to eliminate dividends payable (in consolidation journal):
Dr Dividends payable (balance sheet)
Cr Dividends proposed (income statement)
Journal entry to eliminate dividends receivable (in consolidation journal):
Dr Dividend income (income statement.)
Cr Dividend receivable (balance sheet)
(continues)
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7. Dividend payments pre- and post-acquisition (cont.)
Dividends paid from post-acquisition profits (cont.)
Journal entry to eliminate dividends receivable (in consolidation journal):
Dr Dividend income (income statement.)
Cr Dividend receivable (balance sheet)
Note:
Consolidation journal entries (Chapter 26) are not written in the journals of either company but are entered in a separate consolidation journal
Refer to Worked Example 27.1 on pp. 912–14—Dividend payments to a subsidiary out of post-acquisition earnings
(continues)
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8. Dividend payments pre- and post-acquisition (cont.)
Dividends out of pre-acquisition profits
If an entity pays dividends out of profits earned before acquisition, it is effectively returning part of the net assets originally acquired (return of part of investment in subsidiary)
not to be accounted for as revenue of investor
if dividends are received from pre-acquisition reserves including from pre-acquisition retained earnings, the amount of purchase consideration is correspondingly reduced
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9. Journal entries to record dividends from pre-acquisition profits
Journal entry made in accounts of parent entity (not in consolidation journal):
Dr Dividends receivable
Cr Investment in subsidiary
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10. Journal entry to eliminate inter-entity dividend payable/receivable
To eliminate dividend payable and receivable (in consolidation journal):
Dr Dividends payable
Cr Dividends receivable
Refer to Worked Example 27.2 on pp. 915–18—Dividends paid out of pre-acquisition earnings
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11. Inter-entity sale of inventory
From the group’s perspective, revenue should not be recognised until inventory is sold to parties outside the group
Need to eliminate any unrealised profits from the consolidated accounts
Unrealised profits result from stock, which is sold within the group for a profit, remaining on hand within the group at the end of the period
AASB 127 (par. 25)
Intragroup balances and transactions, including income, expenses and dividends, are eliminated in full. Profits and losses resulting from intragroup transactions that are recognised in assets, such as inventory and fixed assets, are eliminated in full
(continues)
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12. Inter-entity sale of inventory (cont.)
Each member of group taxed individually on its income, not the group collectively
If tax has been paid by one member of the group, from the group’s perspective this represents a prepayment of tax (deferred tax asset)
This income will not be earned by the economic entity until inventory is sold outside the group
(continues)
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13. Inter-entity sale of inventory (cont.)
Journal entry to eliminate inter-company sales
To eliminate total sales as no sales have occurred from perspective of group:
Dr Sales
Cr Cost of goods sold (perpetual) or
purchases (periodic)
(continues)
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14. Inter-entity sale of inventory (cont.)
Journal entry to eliminate unrealised profit in closing stock
Inventory must be valued at lower of cost and net realisable value and on consolidation must reduce value of closing inventory to the cost to the economic entity:
Dr Cost of goods sold (perpetual) or
closing inventory—P&L (periodic)
Cr Inventory
(continues)
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15. Inter-entity sale of inventory (cont.)
Consideration of tax paid on inter-entity sale of inventory
Any tax paid by members of the group related to inter-entity sales where full amount of revenue has not been earned from the group’s perspective, represents prepayment of tax:
Dr Deferred tax asset
Cr Income tax expense
(continues)
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16. Inter-entity sale of inventory (cont.)
Recognition of impairment of goodwill (AASB 3 ‘Business Combinations’)
Prohibition on amortisation of goodwill acquired in business combination
Goodwill required to be tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired (in accordance with AASB 136 ‘Impairment of Assets’)
Per AASB 3 (par. 54):
After initial recognition, the acquirer shall measure goodwill acquired in a business combination at cost less any accumulated impairment losses
(continues)
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17. Inter-entity sale of inventory (cont.)
Recognition of impairment of goodwill (cont.)
Journal entry to recognise impairment loss:
Dr Impairment loss
Cr Accumulated impairment losses—goodwill
Refer AASB 3 (par. 74):
An entity shall disclose information that enables users of its financial report to evaluate changes in the carrying amount of goodwill during the period
Refer to AASB 3 (par. 75) regarding operationalising the requirements of paragraph 74
Refer to Worked Example 27.3 on pp. 919–23—Unrealised profit in closing inventory
(continues)
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18. Inter-entity sale of inventory (cont.)
Unrealised profit in opening inventory
The cost of opening inventory held by one of the entities within the group will be overstated from the group’s perspective
In consolidated adjustments need to shift income from the previous period, in which inventory still on hand, to period in which inventory ultimately sold to external parties
(continues)
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19. Inter-entity sale of inventory (cont.)
Unrealised profit in opening inventory (cont.)
Consolidation entries: Unrealised profits in opening inventory
Reducing opening inventory reduces cost of goods sold:
Dr Opening retained earnings
Cr Cost of goods sold
Higher profits lead to higher tax expense:
Dr Income tax expense
Cr Opening retained earnings
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20. Sale of non-current assets within the group
Assets of the group need to be valued as if the inter-entity sale had not occurred
Need to reinstate the non-current asset to the original cost or revalued amount
Eliminate any unrealised profits on sale
Adjust depreciation
May be tax on profit of sale, which represents a temporary difference
(continues)
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21. Sale of non-current assets within the group (cont.)
Consolidation journal entries to eliminate sale of non-current asset
Reverse gain and reinstate accumulated depreciation:
Dr Gain on sale
Dr Asset
Cr Accumulated depreciation
Recognise deferred tax asset:
Dr Deferred tax asset
Cr Income tax expense
(continues)
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22. Sale of non-current assets within the group (cont.)
Consolidation journal entries to eliminate sale of non-current asset (cont.)
Adjust depreciation to reflect correct amount:
Dr Accumulated depreciation
Cr Depreciation expense
Partial reversal of deferred tax asset to reflect depreciation adjustment:
Dr Income tax expense
Cr Deferred tax asset
Refer to Worked Example 27.4 on p. 925—Inter-entity sale of a non-current asset
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23. Minority interests Example:
Company A (parent entity) owns 75% of Company B
Remaining 25% held by investors who are not part of the economic entity
Outside investors referred to as ‘minority interests’
Minority interests (under AASB 127)
That portion of the profit or loss and net assets of a subsidiary attributable to equity interests that are not owned, directly or indirectly through subsidiaries, by the parent
(continues)
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24. Minority interests (cont.)
Where subsidiary partly owned by parent entity (i.e. less than 100% interest), both the parent entity and the minority interests will have an ownership interest in the subsidiary’s profits, dividend payments, and share capital and reserves
As part of consolidation process, need to work out the amount to be attributed to minority interests
(continues)
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25. Minority interests (cont.)
AASB 127 (par. 22) in relation to the steps in preparing a consolidated financial report
In preparing a consolidated financial report, an entity combines the financial reports of the parent and its subsidiaries line by line by adding together like items of assets, liabilities, equity, income and expenses. In order that the consolidated financial report presents financial information about the group as that of a single economic entity, the following steps are then taken:
the carrying amount of the parent’s investment in each subsidiary and the parent’s portion of equity of each subsidiary are eliminated (AASB 3, which describes the treatment of any resulting goodwill);
(continues)
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26. Minority interests (cont.)
AASB 127 (par. 22) in relation to the steps in preparing a consolidated financial report (cont.):
(b) minority interests in the profit or loss of consolidated subsidiaries for the reporting entity are identified; and
minority interests in the net assets of consolidated subsidiaries are identified separately from the parent shareholders’ equity in them.
Minority interests in the net assets consist of:
the amount of those minority interests at the date of the original combination calculated in accordance with AASB 3
the minority’s share of changes in equity since the date of combination
(continues)
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27. Minority interests (cont.)
Disclosure requirements: minority interests
AASB 127 requires separate disclosure of the minority interest’s share of capital, retained profits or accumulated losses
AASB 127 (par. 33)
Minority interests shall be presented in the consolidated balance sheet within equity, separately from the parent shareholders’ equity. Minority interests in the profit or loss of the group shall also be separately disclosed
Refer to Worked Example 27.5 on pp. 927–30—Consolidated account presentation in the presence of minority interests
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28. Summary
The chapter considered the consolidation process and, in particular, how to account for inter-entity transactions (e.g. dividend payments, sales of inventory, sales of non-current assets) and minority interests
Only dividends paid externally should be shown in the consolidated financial statements—inter-entity dividends paid by one entity within the group are to be offset against the dividend revenue recorded in other entity
The liability associated with dividends payable is to be offset against dividend receivable (as recorded by other entities within the group)
Where inter-entity sales of inventory have taken place and inventory remains on hand at year end, consolidation adjustments are required to reduce the consolidated balance of closing inventory (inventory valued at lower of cost and net realisable value from the group’s perspective)
(continues)
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29. Summary
Where there is sale of non-current assets within the group, consolidation adjustments are required to eliminate any inter-entity profit on sale and to adjust the cost of the asst to reflect the cost of the asset to the economic entity—this may also require adjustments to depreciation expense
Where less than 100% ownership is held, the consolidated financial statements will show a minority interest
AASB 127 requires separate disclosure of the minority interests in the profits, share capital and reserves of the various subsidiaries within the group
If minority interests, the effect of inter-entity transactions will be eliminated in full even though the parent entity might hold only a proportion of the capital of the respective subsidiaries
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